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April 23, 2007

Several Tax Proposals Considered to Pay for Children's Health — Some Better Than Others

Democrats and some Republicans in Congress are hoping to expand the State Children's Health Insurance Program (SCHIP) to cover all low-income children who currently lack insurance. Proponents hope to include such an expansion, which is estimated to cost $50 billion over five years, in legislation reauthorizing the program. (The $50 billion is in addition to funds needed to simply ensure that the program serves the same number of children as it does now.)

Proponents and analysts have discussed several ways of paying for this initiative, most of which fall into one of three different categories. First, some seem to signal that they could just borrow the funds needed to finance SCHIP expansion, which is probably the worst option possible. Second, some want to increase taxes or close tax loopholes to raise the funds needed for SCHIP. This would be a responsible option, but some proposals along these lines (like increasing federal cigarette taxes) are not as good as others (like doing away with tax breaks that can only benefit the wealthy). Third, some support reducing certain unnecessary spending in health care programs in order to fund the initiative, which has the virtue of leaving proposals to raise revenue through the tax code available to fund other initiatives.

(For a longer description of options, see the recent report on this topic from the Center on Budget and Policy Priorities.)

1. Don't bother paying for SCHIP expansion. This is the worst option.

Under procedural rules that will probably be established under the final budget resolution for fiscal year 2008, any new entitlement spending or tax break must offset with spending cuts or revenue increases elsewhere. This rule, known as "pay-as-you-go" or PAYGO, is the budget process reform that successfully eliminated federal budget deficits during the Clinton years, which is why Democrats decided to revive it this year. PAYGO can be waived, however, by a simple majority vote in the House and by a 60 votes in the Senate. Senator Max Baucus (D-MT) got the Senate to approve, almost unanimously, a budget amendment that pledges to waive PAYGO to fund part of SCHIP and to fund extensions of some of the Bush tax breaks.

It must be remembered that every dollar of increased spending or tax breaks that is not offset increases the national debt and therefore increases the interest payments we must make on the debt. Right now 9 cents of every dollar we pay in taxes goes towards interest payments - towards paying for the privilege of borrowing. The amount of our tax dollars that goes towards interest payments instead of spending that benefits Americans will increase a great deal if budget deficits continue. (Supporters of the Baucus amendment may feel that they have not pledged to increase the debt because the amendment targets a budget "surplus" that is projected to appear in 2012. Those projections are misleading because they assume spending of the Social Security surplus and because of unrealistic assumptions about defense spending and other matters.)

All that being said, an SCHIP expansion that is deficit-financed might still be better than no SCHIP expansion at all. It could be the case that the cost of not providing health insurance to children is actually greater than the cost of government borrowing needed to fund the SCHIP expansion. But almost any option that avoids deficit-spending would be better.

2. Raise new federal taxes or close loopholes in federal taxes to pay for the SCHIP expansion. This would be a responsible option, although the some proposals along these lines are better than others.

a. Close loopholes that only benefit the wealthy.

One idea discussed by the Center on Budget and Policy Priorities would repeal two tax breaks that only benefit the wealthy and which are not even fully in effect yet. These tax breaks gradually (from 2006 through 2010) do away with limits on how much wealthy taxpayers can use itemized deductions and personal exemptions. Since these limits target the wealthy, it's estimated that 98 percent of the benefits of these tax breaks go to those with incomes over $200,000 a year. Repealing these tax breaks would yield around $13 billion over five years (really over three years since these tax breaks expire at the end of 2010). While this won't pay for the SCHIP expansion by itself, it could be used with other revenue-raising provisions to fully offset the cost.

b. Raise cigarette taxes.

One idea that could raise most of the needed funds but that would be less progressive is a hike in the federal cigarette tax. Senator Gordon Smith (R-OR) has proposed raising it from the current 39 cents a pack to 99 cents a pack, which he says would raise $46.5 billion over five years. The problem is that cigarette taxes are regressive, as the Institute on Taxation and Economic Policy has pointed out. If two people, one poor and one rich, both smoke two packs of cigarettes a day and both pay 99 cents for each pack, that 99 cents is taking a greater percentage of the poor person's income than the rich person's income. (This is not to say that cigarette taxes serve no purpose at all. If the goal is simply to reduce smoking, cigarette taxes can be effective.)

Despite the regressive nature of cigarette taxes, an SCHIP expansion funded with an increase in the federal cigarette tax is probably better than no SCHIP expansion at all. To see why, one can look to a recent analysis by the Tax Foundation. They project the effects of this proposal on different income quintiles and show that the proposal as a whole is actually progressive, even if the cigarette tax is not. They project the SCHIP spending for each income quintile, minus the additional cigarette taxes paid, as a result of this proposal. The middle income quintile essentially is unaffected while the bottom two quintiles gain and the top two quintiles lose a bit (the wealthiest 20 percent of households lose about $100). The Tax Foundation sees this as evidence that the costs of the proposal outweigh its benefits for too many people, but the clearer implication is that the regressive nature of the cigarette tax can be remedied if the funds are used for a progressive initiative such as SCHIP expansion.

c. Take measures to close the "tax gap."

The IRS has estimated that $345 billion in taxes was not paid correctly in 2001, of which $290 billion was never retrieved or paid at all. Citizens for Tax Justice has offered several recommendations as to how to close this "tax gap," and one of them is to improve capital gains tax enforcement. To do this, Congress would require securities brokers to report a customer's basis (generally the purchase price) in securities transactions to prevent understating the capital gains on such transactions.

Representative Rahm Emanuel has introduced a bill (H.R. 878) that would use this measure to raise revenue to pay for SCHIP expansion. The President's budget included a similar capital gains enforcement measure and the Joint Committee on Taxation estimated that it would raise only $465 million over 5 years. This measure by itself would therefore not be sufficient, but coupled with other tax gap measures and other revenue-raising provisions, this could achieve the goals of tax enforcement while also funding an important social policy initiative.

3. Offset the increased SCHIP funding by making changes to existing spending on health care. This would have the advantage of leaving all the tax-increase options or loophole-closing options to offset other proposals (like AMT reform, alternative energy initiatives, or further reducing the budget deficit).

Several recommendations were recently offered by the Medicare Payment Advisory Commission (MedPAC), a non-partisan body that advises Congress on Medicare, to eliminate unnecessary spending that is not helping beneficiaries. One of the biggest cost-savers suggested is to reduce the payments made to private plans (Medicare Advantage Plans) that provide private coverage through Medicaid. These plans are actually costing more than traditional fee-for-service Medicare that most beneficiaries use, and this proposal would "even the playing field" so that the government is not subsidizing one type of coverage more than the other. The Congressional Budget Office has estimated that this would reduce Medicare spending by $54 billion over five years, enough to fund the SCHIP expansion.

The benefit of finding revenue in this way is that the other options described for raising revenue, which involve changes in the tax code, would still be available to pay for other initiatives in the future.

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The subjects of every state ought to contribute toward the support of the government, as nearly as possible, in proportion to their respective abilities; that is, in proportion to the revenue which they respectively enjoy under the protection of the state - Adam Smith, An Inquiry Into The Nature and Causes of the Wealth of Nations, 1776